By Wayne Cole
SYDNEY (Reuters) - Asian shares were in retreat on Thursday as strains in emerging markets returned with a vengeance and the Federal Reserve further scaled back its stimulus - sending investors scurrying to safety in bonds and yen.
Japan's Nikkei shed 2.5 percent, so surrendering almost all of the previous day's gains. Australian stocks fell 1 percent, while MSCI's broadest index of Asia-Pacific shares outside Japan eased 0.3 percent.
Investors now have to navigate data on Chinese manufacturing where a soft result would only add to skittish mood.
Most Asian markets had rallied on Wednesday on hopes that aggressive rate hikes by Turkey would shore up its currency and ease the risk of capital flight.
However, investors in Europe and the United States seemed less impressed, perhaps worried about the damage higher rates might do to economic growth in these countries.
The Dow ended Wednesday with losses of 1.19 percent, while the S&P 500 shed 1.02 percent. In Europe, the pan-regional FTSEurofirst 300 index fell 0.63 percent.
Indeed, when South Africa's central bank surprised by lifting its rates half a percentage point investors reacted by dumping the rand. Likewise, Turkey's lira saw most of its initial gains stripped away.
That in turn revived demand for safe havens such as the yen, Swiss franc and sovereign bonds. The U.S. dollar fell back a full yen to 102.20, adding to pressure on the Nikkei.
The euro also lost ground on the yen and Swiss franc, but was sidelined on the dollar at $1.3660.
Bonds benefited from the general mood of risk aversion with U.S. 10-year Treasury yields down 7 basis points at 2.69 percent, having hit the lowest since mid-November.
FED STICKS TO TAPERING
The focus on safety was only sharpened by the Fed's well-flagged decision to trim its monthly bond buying program by a further $10 billion.
There had been some talk the wild swings in emerging markets might give the Fed pause for thought. Instead, Barclays economist Michael Gapen noted the Fed made no mention at all of financial markets in its statement.
"In our view, the type of volatility seen in recent weeks is insufficient to cause the committee to alter its policy stance, particularly so soon after tapering began," he added.
"We expect the committee to continue reducing the pace of asset purchases by $10bn at each upcoming FOMC meeting through September and then take a final $15bn reduction in October to conclude QE3."
Many seem to agree, with a Reuters poll of 17 primary dealers in the Treasury market finding all expected QE to be wound down this year.
The prospect of a steady withdrawal of stimulus coupled with improving economies in the developed world has attracted funds away from many emerging markets, particularly those with current account deficits and/or political troubles.
With Brazil, Turkey, South Africa and India all holding elections this year, policymakers are likely to be wary of hiking rates too much to avoid damaging economic growth.
The vulnerabilities in the emerging world were noted by the Reserve Bank of New Zealand when it decided to hold off on raising interest rates on Thursday.
The central bank kept rates at a record low of 2.5 percent but said it was likely to start tightening soon, given the strength of the domestic economy and growing inflationary pressures.
In commodity markets, gold found itself back in favour as a store of wealth at $1,265.84, having climbed over $10 on Wednesday.
Oil prices were modestly higher with U.S. crude 26 cents firmer at $97.63 a barrel. Brent had ended Wednesday up 32 cents at $107.73 a barrel
(Editing by Eric Meijer)
